Bernstein admits change of heart at ARS conference

Peter Bernstein, author of “Against the Gods”, the best-selling book on the history of risk, now says he “got the point all wrong” in the book. Bernstein, giving the keynote address at Risk magazine’s Alternative Risk Strategies 2001 conference in New York yesterday, said he became too impressed with – and focused too much of the book on – the history of mathematical and modelling accomplishments, like the development of probability theory and the Black Scholes option pricing model. This blinded him to the importance of their applications.

“That [mathematical] work is useless without also looking at the laws of decision-making,” Bernstein said. “Information is only the first step. You also have to understand intentions.” Even so, he applauded trends like the convergence of insurance and capital markets that has created the alternative risk solutions field. “Finance is one of the most innovative fields there is – that’s why it attracts so many creative people,” he said.

Other speakers highlighted the latest alternative risk technologies. Denis Autier, head of global risk solutions at BNP Paribas, discussed the firm’s new 'tender hedge' product, which allows construction firms bidding on large infrastructure projects to hedge their currency exposures. Tom Skwarek, principal at Swiss Re New Markets, discussed contingent capital products such as the Michelin and Royal Bank of Canada transactions. Other speakers discussed the use of insurance to facilitate mergers and acquisitions, financings and restructurings.

Several speakers said an AIG subsidiary’s decision to dispute payment on an insurance policy it provided for some film finance bonds has caused a number of problems for the ARS market. In particular, it has raised questions about insurance companies’ willingness to pay. Tobey Russ, president of Chubb Financial Solutions, the conference’s sponsor, said, “The rating agencies have been burned by bonds wrapped by insurance policies, so they have a healthy degree of scepticism about insurers' willingness to pay. We’ve noticed this when comparing insurance versus credit default swaps for a client. The film finance deals have been a stumbling block for the whole industry.”

The situation has spurred interest in developing standardised documentation for ARS transactions. “The Hollywood deals really hurt the business and we need to move to more standardised agreements,” said Swiss Re’s Skwarek. “You’ll see more transparency and standardisation of contracts in the next 12 months or so, so rating agencies and clients know what to expect,” he predicted.

Several speakers pointed to challenges raised by regulators' growing adoption of fair-value accounting rules, reflected in accounting standards like IAS 39 and FAS 133. Michael Brosnan, a partner at Ernst & Young, said, “Insurance doesn’t reflect the time value of money, so since the earliest days of the ARS market, you have been able to get big margins.” But mark to market, fair value accounting does reflect the time-value of money, so its adoption may eliminate this advantage, he said.

In a closing roundtable discussion, representatives from Element Re, Aquila and Chubb Financial Solutions reviewed developments in the weather derivatives market. Nick Mooney, chief executive of I-Wex and the roundtable moderator, said the market’s perennial problem remains the lack of data, although this is slowly improving. Others noted that most end users – primarily energy companies – are looking to buy, rather than sell weather protection, so there is a pressing need to find more institutions willing to take positions on both sides of the market.